The energy crisis triggered by Russia’s invasion of Ukraine in late February has highlighted Europe’s still-heavy dependence on fossil fuels, especially natural gas from Russia. Regardless of how the war evolves from here, the attack has inflicted lasting damage on Russia’s relationship with Europe and set in motion a long-term shift away from Russian energy. In the short-term, Europe’s renewed focus on strengthening energy security will mean seeking immediate alternative sources of energy and expanding infrastructure to receive bigger deliveries of liquefied natural gas (LNG) imports to reduce its reliance on pipeline gas from Russia. Over the next few years, however, we expect to see much greater efforts to accelerate the deployment of renewable energy across Europe, driving investments into renewable energy sources, energy storage technologies and other supporting infrastructure for renewables as governments seek to further diversify their energy mix and reduce vulnerability to future energy disruptions.
Against this backdrop, we prefer companies with leverage to the energy theme (both traditional and renewables), as they offer a confluence of volume growth to help close the energy deficit and relatively better risk-reward propositions at current levels. The companies span across the energy, industrials and utilities sectors. As such, investors will need to be aware of individual sector developments as well. Also, macro developments such as the Covid-19 related lockdowns in China may weigh on energy demand and sentiment in the meantime.
We believe the renewed urgency around energy independence will support future earnings trajectory of companies exposed to the renewables theme.
Urgency for energy independence in Europe to accelerate search for alternatives, such as renewables
We strongly believe that the implications for Europe’s energy policy are likely to extend well beyond the end of the war, even in the optimistic scenario of a near-term resolution to the conflict.
In particular, we expect to see much greater efforts to diversify Europe’s energy mix away from pipeline gas imports from Russia and from fossil fuels more broadly.
Higher energy prices and climate change to push energy transition in other parts of the world
In other parts of the world such as the US, the urgency is likely to be less than Europe given the large amount of domestic natural gas production in the US. However, higher energy prices should also incentivise additional buildout of renewable energy, all else equal. Moreover, energy security and climate change will remain important areas of focus for any forward-looking government, and the potential for more focus could revitalise support for federal clean energy incentives such as those proposed as part of the Build Back Better legislation championed by US President Joe Biden.
On 8 March 2022, the European Commission (EC) announced a plan, REPowerEU, for dealing with the energy crisis and reducing dependence on Russian gas. Among the various proposals such as reducing energy use and increasing imports of LNG from other sources, the EC also proposed to accelerate the near-term deployment rate for renewables by 20% versus its existing Fit for 55 strategy, adding an extra 80 gigawatts (GW) by 2030 to accommodate an additional 5 million tonnes (mt) of green hydrogen production, split roughly 50/50 between wind & solar. The new targets envisage 480GW of wind by 2030 (vs. approximately 190GW in 2021), with the revised targets for wind (which do not split out onshore/offshore, but prior targets were an 85%/15% ratio) implying average installations of 32GW per annum (vs. 11GW in 2021). This represents a strong improvement in outlook and we believe the renewed urgency around energy independence will support future earnings trajectory of companies exposed to the renewables theme.
...while electric vehicle demand may impact oil demand, it will be some time before the impact is meaningful.
Energy transition and energy security not mutually exclusive
In the meantime, however, the energy crisis experienced in various parts of the world since the later part of 2021 has highlighted the fragility of the energy supply chain which can have far-reaching effects. High energy prices boosted the MSCI All-Country World Energy Index to be the best performing sector in 2021 and the sector is also faring relatively well year-to-date in 2022.
Overall, we see continued broad-based support for the adoption of renewables, electric vehicles, carbon capture, and other technologies as compatible with ensuring secure traditional energy sources to meet the demand of consumers. For example, in the US, Morgan Stanley Research projects a near-quadrupling of renewable power output from 2020 to 2030, but this will barely dent natural gas demand. That said, this renewables growth is expected to result in a significant reduction in coal power plant output and a 75% decarbonisation of the US power sector by 2030 (off a 2005 baseline). Renewable energy is likely to have little direct impact on US oil consumption. And while electric vehicle demand may impact oil demand, it will be some time before the impact is meaningful. Globally, oil-based fuel consumption now stands 3% above pre-Covid levels. While countries in Asia are working toward energy transition, their demand for natural gas and coal continues to rise.
Focus on LNG as Europe seeks alternative sources
Meanwhile, because of the increased urgency to reduce Europe’s dependence on Russian gas, Europe is likely to increase imports of LNG from various sources, such as the US. Cargoes meant for Asia could also be bid up with Europe coming into the fray.
It is also envisaged that LNG carriers would be required to meet the demand of increased cargos in the future, which would benefit shipbuilders specialised in this area. In Europe, most of the shipbuilding work that is done is mainly defence-related or for the cruise industry.
Monitor cost inflation especially in US shale and renewable energy
Amidst the rush towards energy names, we want to highlight that investors should keep in mind the effects of higher inflation on the sector. The consistent message from the last reporting season has been that US shale operations and renewable energy generation is experiencing the fastest cost inflation in recent memory.
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